Exploring the Application of Factor Analysis in Portfolio Optimization

DOI: https://doi.org/10.62517/jbm.202409503

Author(s)

Qingyang Li*, Yilin Wang, Zijin Huang, Qihong Xie

Affiliation(s)

School of Mathematical Physics, Xi 'an Jiaotong-Liverpool University, Suzhou, Jiangsu, China *Corresponding Author

Abstract

This paper reviews the application of factor analysis to portfolio optimization. First, we define the objective of portfolio optimization and provide an overview of traditional optimization methods, including mean-variance optimization and capital asset pricing models. We then discuss the challenges of portfolio optimization, including factors such as market changes, asset correlation changes, and market frictions. We then delve into the basic concepts and principles of factor analysis and its application in finance. We analyze the role of factor analysis in portfolio optimization, including the importance of factor selection, implementation steps, and the advantages and limitations of the method. Through literature review and case studies, this paper summarizes the empirical research results of factor analysis in portfolio optimization and makes suggestions for future research directions. Finally, we emphasize the potential of the factor analysis approach in improving the efficiency and accuracy of investment decisions, and point out the challenges that need to be overcome in its practical application.

Keywords

Portfolio Optimization; Factor Analysis; Risk Management; Asset Allocation

References

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